Tariffs and Inflation: What's Your Thesis?

Tariffs and inflation will likely dominate the narrative in existing and prospective client conversations this year. A well-developed thesis—a timely, pithy, soundbite that connects the dots to the advice you're delivering—can help create curiosity gaps in four dimensions of conversation to drive organic growth:

• Make first encounters count
• Generate more meetings
• Answer "Why us?" in first meetings
• Capture referable moments

We caught up with managing director Jitania Kandhari from Morgan Stanley on her thesis: "There is too much linear thinking in today's markets." Jitania's thesis creates a curiosity gap since her view challenges current consensus. The below excerpt from our recent conversation provides additional context:

David: "There is a prevailing belief that the incoming Trump administration's proposed tariffs will inevitably trigger inflation and lead to higher rates. You believe the opposite, correct?"

Jitania: "Correct! Imposing tariffs will not automatically lead to higher inflation and may in fact even harm U.S. industries. The idea of introducing broad tariffs of 10% to 20%, or even up to 60% on China, may seem like a straightforward solution to protect American industries, and yet, it's unrealistic for two compelling reasons:

• First, about 40% to 50% of U.S. imports are intermediate goods, and imposing tariffs would act as a tax on domestic manufacturers, increasing their production costs and penalizing U.S. exporters. Tariffs will have a detrimental impact on U.S. supply chains and production capacity.
• Second, unrestricted tariffs could ignite a wave of retaliatory measures from trading partners. The complexities of global trade mean any unilateral action can provoke a backlash, leading to a vicious cycle of escalating tensions and retaliations that can in fact harm growth and lower inflation."

David: "What will the impact be if significant tariffs are levied despite these two compelling reasons?"

Jitania: "If imposed, actual impacts of tariffs are complex and require a nuanced perspective. Tariff impacts can be offset in several ways: corporate profit margins absorbing costs, supply chain diversions, demand displacement, product substitution and currency adjustment. These are all coping mechanisms to minimize the impact."

David: "What are your takeaways on the inflationary impact of tariffs based on the recent past?"

Jitania: "Historical evidence from the last Trump presidency challenges the notion that tariffs will directly lead to inflation and higher interest rates. For instance, when Trump took office in 2017, core personal consumption expenditure (PCE) inflation stood at 1.8%, yet it fell to 1.6% three years later before the COVID pandemic despite the implementation of tariffs."

"Currency depreciation can also soften the blow from tariffs. For example, the renminbi (RMB) depreciated by 11% following the Trump tariffs in 2018, effectively cushioning some of their adverse effect. On the other hand, a stronger dollar makes imports cheaper, countering some of the inflationary pressures that tariffs might otherwise create. If we go back further in time, there is a historical parallel with Japan when the country faced similar tariffs from the U.S. in the 1980s. The yen depreciated significantly forcing central bankers to ultimately negotiate the Plaza Accord in 1985 to stabilize the currency. This interplay between currency values and tariffs also shows how these economic relationships are rarely linear."

David: "China is a big part of the tariff conversation and the fear of inflation. As a huge student of China, can you share your thoughts?"

Jitania: "Today, Chinese export prices remain the lowest in the world allowing Beijing to export deflation because of its excess manufacturing capacity. Lower US demand for Chinese-made goods, combined with efforts by Chinese companies to sustain current production levels have led to increases in the supply of Chinese goods to other major economies, putting modest downward pressure on ex-US core prices. Several central bank officials—including ECB President Lagarde and RBA Governor Bullock—have raised this point to emphasize that a global trade war would not necessarily be inflationary and that the net inflation impact would depend on how countries retaliate."

Bottom Line: You get paid to have an opinion, especially when it comes to the big market memes of the day. Develop a timely thesis and be prepared to back it up with in-depth analysis.